Monday, 18 June 2012

Defence ministry to dilute offsets next week

by Ajai Shukla

Business Standard, 18th June 12

The ministry of defence (MoD) is poised to sharply dilute its Defence Offset
Guidelines (DoG) during the coming fortnight.

MoD and industry sources tell Business Standard that among the amendments the
apex Defence Acquisition Council (DAC) is to clear on June 24 is one that would
allow foreign vendors to discharge their offset obligations with minimal
production and value addition in India.

While some of the likely amendments to the DoG are broadly acceptable, a
controversial new proposal has set alarm bells ringing among Indian defence
producers. This innocuous, but far-reaching, amendment relates to how ‘value
addition’ will be calculated when an Indian Offset Partner (IOP) produces a
system or a sub-system for a foreign vendor (offset credit is only given for
value addition in India). Imported items have always been excluded from the
‘value add’, calculated as the IOP’s billed cost for the equipment supplied to
the foreign vendor, less the cost of imported items used by the IOP. The
proposed amendment would allow the IOP to buy foreign parts from Indian
sub-vendors, and present that as value-add, provided the sub-vendor is paid in
rupees.

Illustration

In practice, here’s how this would work.
Consider a hypothetical offset-related contract that a foreign vendor, Smith
Aerospace, signs with an IOP, Jai Bhagwan Hydraulics. If Jai Bhagwan uses Rs 80
crore worth of imported components in Rs 100 crore worth of hydraulic pumps that
it supplies Smith Aerospace, the existing offset policy gives Smith Aerospace
offset credit for Rs 20 crore, i.e. the value the IOP has added in India (billed
cost, less cost of imported components). The new proposal changes this
calculation fundamentally by defining value-add as billed cost, less the import
cost incurred by the IOP.

In practice, this would allow Smith Aerospace to generate Rs 100 crore worth
of offset credit through the same transaction, merely by encouraging Jai Bhagwan
Hydraulics to buy the imported components (worth Rs 80 crore) from an Indian
sub-vendor. Though the components remain imported, they would be treated as
value-add, simply because the IOP, Jai Bhagwan, has not imported these (and has,
in fact, paid the sub-vendor in rupees). This would entitle Smith Aerospace to
claim offset credits for the full Rs 100 crore.

This only requires a slight amendment to Para 6.4 of the current Defence
Procurement Procedure of 2011 (DPP-2011). The DAC will discuss this amendment on
June 24. MoD did not respond to questions on the subject.

“Instead of encouraging the Indian defence industry to produce in-country,
this amendment effectively legitimises imports. Instead of the Indian Offset
Partner doing the import, the Tier-2 supplier will do it. The foreign vendor
will get enhanced offset credits without any extra production having taken place
in India,” points out the CEO of an Indian defence company, who has requested
not to be identified.

The new policy also incentivises foreign vendors to select micro, small and
medium enterprises (MSMEs) as their offset partners, by introducing a multiplier
of 1.5 for offsets discharged through MSMEs. That means if Jai Bhagwan
Hydraulics were an MSME (according to the monetary guidelines specified by the
department of micro, small and medium enterprises, the offset credit to Smith
Aviation would be multiplied to Rs 150 crore (Rs 100 crore times 1.5).

Ironically the revised policy will, for the first time, explicitly state that
the offset policy is aimed at developing Indian defence industry. The threefold
aim it specifies is “to leverage capital acquisitions to develop the Indian
defence industry by (i) fostering development of internationally competitive
enterprises, (ii) augmenting capacity for research, design and development
related to defence products and services and (iii) encourage development of
synergistic sectors like civil aerospace and internal security.”

Other changes

The proposed policy would also permit
transfer of technology (ToT) as offsets; granting any foreign vendor a
multiplier of three for technologies specified by the Defence R&D
Organisation (DRDO). It extends by two years the period within which vendors
must discharge offset obligations and extends the validity of banked offset
credits to seven years (it was earlier two years). In complex procurements (like
the recent medium fighter contract) where multiple sub-vendors incur offset
liabilities, the new policy will permit sub-vendors to individually discharge
their respective liabilities, even while holding the main vendor responsible for
discharging offsets in full.

Another amendment being discussed on June 24 could resolve a six-year debate
that has exercised the MoD — which agency should administer offsets? One group,
supported by the army and air force, has argued the powerful Acquisitions Wing
should oversee offsets, since it buys the foreign arms that create offset
obligations. Other bureaucrats apprehend a conflict of interest that might
foredoom offsets, since the Acquisitions Wing’s primary mandate of expeditious
procurement pre-disposes it to regard strict offsets as an encumbrance. This
group argues that as offsets aim at boosting indigenous defence production
capability, they should be handled by the department of defence production
(DDP), a separate MoD wing that is led by a secretary.

MoD sources say the proposal that the DAC will examine gives the Acquisitions
Wing responsibility for concluding offset contracts alongside each procurement
contract. The DDP will, thereafter, oversee the discharge of offsets.

Offsets were first made mandatory in the Defence Procurement Policy of 2006
(DPP-2006) and then revised periodically. The policy requires foreign vendors
who win defence contracts worth Rs 300 crore or more to plough back at least 30
per cent of the contract value into India in the form of defence orders,
technology or infrastructure.

The amendments now proposed continue the MoD’s steady dilution of this
policy. Global arms vendors, backed openly or tacitly by their governments, have
mounted a sustained lobbying campaign against offsets, arguing that Indian
defence players do not have the capacity to absorb the offset production that
will arise. Meanwhile, India’s defence producers have argued that the very aim
of the offset policy is to develop production capacity and, therefore, the
foreign vendors must assist in building up capacities. The MoD, by incrementally
diluting the offset policy, has indicated that it supports the foreign arms
vendors.

I was hoping if you could shed some light on the kaveri project that drdo just gave up... then drill those fuckers for spending all those money... I mean put your article in every paper and possible get some one to explain how you could just throw in the towel

It all boils down to Dissemination of Information; the civvy street is NOT even aware of such Articles and amendments - there are no discussions - just plain babus, who(after receiving sufficient incentive) will change anything... and the sad part is that the Men In Uniform will get a bad name :(

This is why democracy in a country as varied as ours can NEVER work. Democracy means lowest common denominator. Sometimes, I feel that we may have been better off with the British Raj. They may have eaten as much as our Babus, but they would also have done a lot of good.

It is not a wrong idea. If IOP wants an extra share of revenue it can start building the product in house instead of importing it. For instance, Kai Bhagvan Hydraulics can make that part for say 50 crore and sell it for 100. At least it will be better than likes of BEML who sold directly to forces at inflated prices